Sunday, September 06, 2009

An very interesting piece by Paul Krugman published in New York Times...

It’s hard to believe now, but not long ago economists were congratulating themselves over the success of their field. Those successes — or so they believed — were both theoretical and practical, leading to a golden era for the profession...

Friday, September 04, 2009

Just six months ago, millions of would-be investors were reluctant to move into equities because the market was falling too fast. Now many are wary because the market is rising too fast. In the meantime, life moves on.

Any financial advisor will recognise the syndrome. It's like watching a child standing tentatively at the edge of a swimming pool. She's torn between her desire to join the gang and her fear of getting cold and wet. But if she leaves it too long, she misses the opportunity altogether and it's going home time.

In retrospect, of course, it would have been better to get out of the equity market completely in October 2007 and move into cash and government bonds, before reversing course again in early March 2009.

The reality is that correctly timing your exit and entry to the market is impossible. If it were as easy as some claim, millions would be doing it and getting very rich in the process. Some of us would be writing books about it and going on TV business shows to promote our "timing secrets".

The reason timing stories are back in the news is because some analysts and commentators are questioning the sustainability of the recent rally in share markets. With major indices 40-50 per cent or more above their March lows, the word is that valuations are no longer compelling and that the economic recovery will be a sluggish one.1

Others go further and say this is a "sucker's bounce" in a longer-term bear phase that could take the market back below the March lows. These bears are nervously eyeing October, traditionally seen as a shaky time for markets.

It's no wonder, then, that some nervous investors who missed the March-to- August rebound are now afraid of getting in because they think the market is too elevated, while others who stayed invested are wondering whether they should take some profits off the table.

At one end of this emotional spectrum of investing is regret about what has already been lost. At the other is a combination of fear and greed at what the future could hold. All of these feelings are understandable and reflect the fact there will always be uncertainty in investing. With return comes risk, after all.

But while no-one yet has come up with a consistently successful strategy for timing the market to perfection, there are some things that everyone can do to help ease the anxiety they feel about investing.

One is to realise that it does not have to be a choice between being 100 per cent in the market and 100 per cent outside. Ideally, an investor should stick to their strategic asset allocation — be it 70/30 or 60/40 or 50/50 equity/bonds.

Another is that this strategic asset allocation can be combined with periodic, disciplined rebalancing, in which the investor shifts assets from well performing asset classes to those less favoured. This is a good way of controlling risk without necessarily trying to time the market.

A third option is that there is nothing wrong with investors taking into account the returns they have already enjoyed and adjusting their asset allocations if they are on course to meet their goals. So, for example, for some investors it might make perfect sense to lock in returns after a good period and put the money into short-term fixed interest if that meets their needs.

Yet another option is dollar-cost averaging. This is a method where an individual invests small amounts of an available pool of cash into the market over a period, rather than investing a lump sum in one go.

Dartmouth finance professor and Dimensional director Ken French tackles this subject in a recent video interview. From his standpoint as a professor, French says that the optimal decision is to put all of the money into the market today. But he adds that while this might give an individual the best investmentoutcome, it might not be the best investment experience.This is because people tend to feel regret more strongly when it results from things they did do than from things they did not. So, for instance, it feels much more painful to buy stocks now and see the price go down than it is to neglect to buy stocks (like back in March) and the price goes up.

French says by dollar cost averaging, people can diversify their "acts of commission" (the stuff they did do) as opposed to their "acts of omission" (the stuff they didn't do).

"The nice thing is that even if I put finance professor hat back on, it's really not that damaging to your long-term portfolio to just spread it out over three or four months," French says. "So if you as an investor find that's much more tolerable for you, you're not really doing much harm."

So, in summary, it's always difficult to choose exactly the right time to get back into the market. Ideally, it would have been nice to get out in late 2007 and back in around early March this year.

But most mortals are unable to finesse it to that degree. The good news is that there are other options than just staying out of the market altogether and plunging back in.

These include maintaining a long-term strategic asset allocation in the first place, periodically rebalancing, taking money off the table if retirement goals are on track and dollar-cost averaging if that provides comfort.

The underlying philosophy in all these options is that individual investors are making decisions based on their own needs and risk appetites, not according to someone else's opinion as to what the market does next.

Uncertainty will always be an integral part of investment (and life). But there are many things we can control. And this is where a good advisor comes in.

Wednesday, August 26, 2009

The worst must be over. Investing is back on the acceptable list of dinner party conversation topics.

A few short months ago bringing up almost anything to do with investing – super or sharemarkets in particular – was a real party conversation stopper. People would quietly move away to start up a conversation about something more interesting – anything was more interesting than super.

But it’s back. At this point the behavioral finance academics are all nodding sagely and reminding us that our emotional drivers should not be underestimated – losses hurt both our portfolios and our egos. Denial arrives and people stop looking – and talking - about it.

Then along comes a 40% rally on the Australian market since early March and suddenly its OK to be talking shares and super again.

Hindsight is a wonderful thing but it would have been really insightful to have surveyed a group of investors back in early March and asked them whether they thought it was a good time to invest...

Wednesday, August 12, 2009

Widely cited as the father of the efficient market hypothesis and one of its strongest advocates, Professor Eugene Fama examines his groundbreaking idea in the context of the 2008 and 2009 markets. He outlines the benefits and limitations of efficient markets for everyday investors and is interviewed by the Chairman of Dimensional Fund Advisors in Europe, David Salisbury.

The global financial crisis and a series of recent scandals have turned a critical light on much of the investment industry and led to public questions about the role and value of financial advisors.

Against the backdrop of the worst market downturn in decades, many advisors report that they have struggled to enunciate their value proposition.

For those whose perceived their value to their clients as an ability to deliver positive investment returns year after year, irrespective of the state of markets, this existential crisis is understandable.

And for those who sell their expertise as consistently accurate forecasters, the self-doubts may have been even more corrosive.

But there is another group who understand that the value they bring is not dependent on the state of markets. Indeed, their value can be even more evident when markets are down and fear is running high.

The best of these advisors play multiple and nuanced roles with their clients, depending on the stage of the relationship, and are amply rewarded for the manifest skills they bring to the table.

While some may quibble over the exact characterisation, broadly these functions break down to seven important roles that evolve over time:

The expert: Now, more than ever, investors need advisors who can provide client-centred expertise in assessing the state of their finances and developing risk-aware strategies to help them meet their goals.

The independent voice: The global financial turmoil of the past two years has demonstrated the value of an independent and objective voice in a world full of product pushers and salespeople.

The listener: The emotions triggered by financial upheaval are real. A good advisor will listen to client's fears, tease out the issues driving those feelings and provide practical long-term answers.

The teacher: Getting clients beyond the fear-and-flight phase often is just a matter of teaching them about risk and return, the power of diversification, the importance of asset allocation and the virtue of discipline.

The architect: Once these lessons are understood, the advisor becomes an architect, helping clients to build a long-term wealth management strategy that caters to their own risk appetites and lifetime goals.

The coach: Even when the strategy is in place, doubts and fears will inevitably arise in the client's mind. The advisor at this point becomes a coach, reinforcing first principles and keeping the client on track.

The guardian: Beyond these early experiences is a long-term role for the advisor as a kind of lighthouse keeper or guardian, scanning the horizon for issues that may affect the client and keeping them informed.

These are the seven faces of advice and, when properly applied, become testimony to the fact that the value of a good financial advisor extends well beyond the writing of a simple financial plan.

A prospective client may first seek out an advisor purely because of their role as an expert. But once those credentials are established, the main value of the advisor in the client's eyes may be their role as an independent voice.

Knowing the advisor is truly independent — and not a product salesperson — leads the client to trust the advisor as a listener or sounding board, as someone to whom they can unburden their greatest fears.

From this point, the listener can become the teacher, the architect, the coach and ultimately the guardian. These are all valuable roles in their own right and none is dependent on forces outside the control of the advisor, such as the state of the investment markets.

However you characterise these various roles, good financial advice ultimately is defined by the patient building of a long-term relationship founded on the values of trust and independence and knowledge and the recognition of our common humanity.

Sunday, August 02, 2009

Few issues are more controversial in super than how super fund investment performance is reported and discussions about which factors drive fund performance.

Consider the position of the Australian Prudential Regulation Authority (APRA) regarding fund performance. It finds itself at the epicentre of a debate that still has considerable distance to travel before some form of industry consensus is reached and even further before clarity from an investor’s perspective can be achieved.

Long-serving deputy chairman of APRA Ross Jones has publically described one of the regulator’s functions as being a “disinterested reporter” of statistical information that is “in most cases non-contentious”.

But then adds Jones somewhat poignantly: “The main exception to the ‘non-contentious’ point … arises in our superannuation publications, most notably those sections of the publications which reveal relative return differences between funds entrusted to not-for-profit and retail trustees.”

There are two central causes behind the latest burst of contention around APRA regarding super fund performance. First, there is its imminent reporting of individual fund or trustee performance. And then there is the release last week of a “working paper” covering why some types of funds outperform others in the view of two APRA researchers.

Within the next six weeks or so, APRA will publish for the first time a performance table showing the return on assets achieved by individual super funds or trustees. To date, it has only reported the return on assets of fund sectors (divided into retail, industry, public-sector and corporate funds with $50 million-plus in assets).

APRA’s first fund-level performance figures will cover the five years to June 30, 2008.

In short, APRA believes that its revamped approach will enable fund members to compare fund performance in a more informed way.

Specialist superannuation researchers SuperRatings, Chant West and SelectingSuper already provide performance figures at fund level with the after-tax, after-fee returns divided into the most-common portfolio types (typically high-growth growth, balanced or default and conservative). And often the most accessible information gives the returns of the top-10 performers over various periods.

If the debate over investment performance wasn’t hot enough, two APRA researchers Wilson Sy and Kevin Liu last week presented a research working paper Investment performance ranking of superannuation firms, which truly stoked the fire along. The paper carries the clear rider that the views and analysis are those of the authors and do not necessarily reflect those of APRA. (See http://www.apra.gov.au/Research/upload/SA_WP_IPRSF_062009_ex.pdf)

The paper is an interesting, technical review of various methodologies for assessing fund performance and risk. It looks at the issue clearly from the perspective of a member of an institutional-style super fund, however for trustees of their own self-managed super fund it provides an interesting summary of a broad range of industry research.

The challenge the researchers have set themselves is to come up with a “new and more reliable way for individual investors to make investment selections for their retirement savings”.

No small undertaking and one that they believe requires quarterly asset allocation data of the total super fund. The key difference with this approach is that rather than rank the individual funds or portfolios they are looking to compare the performance of the management firm or its composite portfolios. So the focus is more on the effectiveness and governance of the organisation rather than an individual fund or portfolio.

In their working paper, Sy and Liu also raise a number of issues based on five years of annual data (from 2002 to 2006) for 115 super funds.

The average firm under-performed its net benchmark by 0.9% and the net under performance of the average firm appears more pronounced in down markets.

Higher operational costs of super funds “correlated significantly” with lower investment performance. In other words costs matter and in investing the more you pay as an investor the less you get once all fees and taxes are deducted.

Super funds can “reduce their overall operation costs by negotiating lower fees with service providers … Or, the pension firms [super funds] can avoid paying high active management fees by using passive management for a larger proportion of its assets”.

Asset allocation is a major driver of investment performance

High ranking performance does not appear to persist over the long term

The researchers are proposing the development of a new measure – risk adjusted value added (RAVA) – as a result of their analysis with the aim of helping investors make better informed fund selection decisions.

To achieve that APRA will need to collect quarterly asset allocation so it will be interesting to see if that is indeed a future development for APRA’s performance table that was championed by the former Minister for Superannuation, Nick Sherry.

The role of regulator is an often thankless task so credit is due for confronting and contributing to the debate – even if this does not prove to be the final solution.If investors end up with simple, transparent measure that help make better choices about which super fund is right for them the entire industry will be a winner.

Wednesday, July 29, 2009

Politicians and economists share a common ability to fearlessly predict the way forward where mere mortals see confusion and uncertainty…

So it was refreshing to read the essay by the Prime Minister, Kevin Rudd, at the weekend. Naturally there was a fair bit of political positioning within it but the overriding message was a good reality check.

The sharemarket has enjoyed a rally since mid-March – and the S&P/ASX 200 index has recovered all the ground lost since last November - but this week commentators were excited about a 10-day winning streak. Now the best run of days of consecutive gains since 2004 and the strong positive news on the investment return front that flows from that is more than welcome given what investors have had to endure in the past 18 months.

But it would be easy to get carried away and think the worst has been put behind us and that it is all upside from here. Which was what made the Prime Minister's rather sober commentary noteworthy...

Thursday, July 23, 2009

The post-mortem on the global financial crisis is raising the question in some minds about whether it is time to read the last rites for diversification — the principle that you reduce your investment risk by spreading it around.

Among the would-be mourners are critics who say the diversification principle failed spectacularly for investors just when they needed it the most — during the biggest market meltdown seen in generations.

After all, the idea behind diversification is that no two investments perform in exactly the same way at the same time. By mixing up the asset classes in your portfolio and diversifying within those asset classes, the idea is that you provide yourself with a cushion or shock absorber in the down times.

But then came the financial crisis of 2008 and suddenly there seemed to be no safety net. Just about every asset class — apart from government bonds and cash — got walloped. In the jargon of financial economists, those asset classes appeared to become much more "correlated".

But the appearance of rising correlations does not necessarily mean that diversification does not work. And you can prove that by considering what might have happened if investors had been less diversified than they could have been last year.

It's a point made by Dartmouth Tuck School of Business finance professor Ken French in a new video on the forum he co-hosts with Eugene Fama, a finance professor at the University of Chicago Booth School of Business.

"Diversification still works," French explains in the interview. "And they (investors) would have had even more uncertainty about the return on their portfolios if they had been poorly diversified."

French points out that diversification does not eliminate the volatility of theoverall market. What it does do is protect against the additional volatility arising from the characteristics of individual firms or asset classes.

"It's that extra volatility that you don't have to have if you diversify well."

On the question of rising correlations in highly volatile markets, French notes that the return on any asset comprises two components — the market return itself and the return attributable to the specifics of the individual asset.

During the extreme volatility of 2008, the market movement became proportionately much more influential so that it appeared that individual stocks and asset classes appeared to be much more lined up with each other.

"What matters when we think about diversification is the firm-specific pieces, not the market piece," French says. "And we know that in these volatile periods, the firm-specific pieces also get bigger. So while it may look like the benefits of diversification have gone down, they have actually gone up."

These differences in the firm-specific variation in returns are what financial economists call "cross-sectional dispersion". And it is well established that just as market volatility tends to spike after periods of negative performance, so do the cross-sectional dispersions.

This table below shows the performance of four Australian portfolios (cash, simple diversified, sub-asset class diversified and all equities) over three different periods - the peak months of the financial crisis (Nov 2007 to February 2009), the recent recovery (March 2009 to June 2009) and the past quarter century.

The simple diversified portfolio ("Diversified A") is just 70 per cent Australian equities, 25 per cent bonds and 5 per cent cash. The sub-asset class portfolio ("Diversified B") breaks up the Australian equity component into large, value and small components. Common indices are used.

You can see that even during the worst of the crisis, a diversified portfolio provided a better result (or at least a less bad result) than an all-stock portfolio. While cash was clearly the best result of the three in this period, look at contrast between the three portfolios in the subsequent, admittedly very short, recovery period. Note too, that the Diversified B portfolio has performed better in the rebound, reflecting the tendency of small and value stocks to do outperform around economic turning points.

However, the key message is in the longest time period here, covering early-1985 to mid-2009. This shows returns from the diversified portfolios were very similar to the all-stock portfolio, but with much lower volatility.

What this all means for investors is that the need for broad diversification both across and within asset classes becomes even more important at times of high volatility.

In the words of Mark Twain, reports of the death of diversification have been greatly exaggerated.

Tuesday, July 21, 2009

...it is possible to invest without fretting over the ups and downs of the market.

A passive or indexing approach to investing involves concentrating on the things that we can actually control—asset allocation, fees, transaction cost and efficiency with which strategies are implemented.

This approach certainly does not offer a quick-fix and it does not carry any of the seductive qualities of gambling or day-trading. It not offer the sizzle that the media likes and if you are looking to investing to provide an adrenaline rush then you should be looking elsewhere.

Like most things of value in life passive investing takes discipline and time to reap the rewards. The process is based on a solid academic foundation of empirical research and it is the most intelligent and prudent way to build wealth over the long run.

Your investments should not be a cause of stress in your life.

By understanding this approach you will recognize that it offers the most sensible investment solution.

Thursday, July 02, 2009

One of the great myths of the investment world is that you can build a successful long-term strategy around a carefully chosen small number of stocks that are perceived as generating good earnings growth year after year.

Just why this myth refuses to die may be a testament to the power of hope over experience. But it's useful now and then to see the dire results of concentrated portfolios, even those chosen by supposed experts.

In mid-2007, the Australian Financial Review's Smart Investor magazine published a front cover story called 'VIP Stocks — 25 Companies that Grow Earnings Year after Year'.1 The 'VIP' tag in this case stood for 'Very Impressive Performers' and was a accompanied by a rather nifty photograph of what looked like a backstage pass.

The implication was that this was the portfolio favoured by insiders. The blue ribbon stocks were chosen after analysts "pored through consensus earnings forecasts for Australia's top 500 listed companies" to find the 25 that they agreed had the best potential in terms of earnings per share (EPS) growth.

This was a detailed and rigorous process, we were told. To ensure the chosen stocks were not "just a flash in the pan", the magazine's analysts insisted on a superlative track record. The companies had to have had at least double-digit EPS growth in both the 2005 and 2006 financial years, as well as "a top earnings outlook" for either 2007 or 2008.

To ensure the companies were generating earnings efficiently, the analysts required that each stock had a return on equity of at least 12 per cent. And to cover the risk that all the good news was priced in, they excluded any company with a price-earnings ratio "wildly above" the industry average.

So given these high hurdles, it would seem reasonable to expect that Australia's top analysts would create a small portfolio that would shoot the lights out, or at least outperform the market, wouldn't you think?

Unfortunately not. Of the 25 "very impressive performers" for 2008, only a mere seven (or less than a third) ended up performing better than the market, as defined by the S&P/ASX-300 Accumulation Index. They were Sonic Healthcare, Computershare, TechnologyOne, IBA Health, Iress Market Technology, Beach Petroleum and JB Hi-Fi.

On the flipside, 18 of the 25 underperformed the market. And of those, 12 lost 60 per cent or more of their value. In fact, the two worst performers in the magazine's list of "VIP" stocks went missing in action altogether. Investment companies Allco Finance Group and Babcock & Brown imploded over 2008 and now are no longer listed.

Overall, if you had decided to put your own money into this concentrated, "rigorously analysed" portfolio of Australian stocks last year, you would have generated an average return of a negative 58.58 per cent, against a negative 38.90 per cent return just by owning the market. And this is even before taking brokerage costs into account.

It should be clear from this that when you hold such a concentrated portfolio you are taking on unnecessary risk. You expose yourself to stock specific and industry factors that can blow your portfolio out of the water.

The fact is it doesn't matter how well those individual stocks have performed up until that point. More often than not, their superlative past performance is recognised by the market and is reflected in prices.

When it comes down to it, investment is about what happens next. We don't know what happens next. And that's why we diversify.

(The writer would like to thank Rob Brown for his assistance with this article)

Sunday, June 28, 2009

It's not often appreciated, but financial television is designed first and foremost as an entertainment medium. And that wouldn't matter so much hadn't real investors used its content to guide their own strategies.

Anyone who has worked as a presenter on network financial television (and this writer is one of them) knows the standard modus operandi is to treat investment like sports news — lots of colour, movement and volume.

That is why when you watch CNBC or one of the other business networks, you see multiple talking heads all yelling over the top of each other while animated line charts criss-cross the screen in a smorgasbord of colour.

But while there is nothing wrong with making entertainment the priority insports, producers who seek to turn investment into a circus could be accused of playing games with the hard-earned wealth of ordinary people.

Fortunately for investors, the networks' game is finally up. The global financial crisis has exposed the failure of many of the self-proclaimed journalists of financial television to represent the interests of the viewing audience.

What changed? Well, as revealed by comedian John Stewart in his much linked interview with CNBC host Jim Cramer [see video below], the business networks started to see themselves as a kind of cheer squad for Wall Street's worst excesses.

Essentially, the finance anchors were so busy throwing soft ball questions to options-driven investment bankers and characterising speculation as investment that they neglected to do the job that they prided themselves on — helping ordinary investors making informed decisions about their money.

Now there are calls for reform of financial television to steer it back onto the path of placing a priority on providing viewers with good, accurate information devoid of sales spin. Making it entertaining should be secondary.

Among the would-be reformers is Barry Ritholtz, a prominent blogger, financial commentator and frequent guest on the business shows.

Ritholtz has drawn up a 16-point menu for change, which includes such sensible suggestions as stopping the yelling, reinforcing the risk-reward trade-off, separating the long-term signal from the short-term noise, checking facts, insisting on accountability and respecting the audience.

This is a menu that Dimensional has been recommending for years. In dietary terms, it is admittedly an approach to investment that is more akin to fresh fruit and vegetables than to popcorn. But it's better for you.

NOTE: LINK TO MAD MONEY MACHINE AT RIGHT WHICH HAS BEEN REVIEWING CRAMER AND HIS STOCK-PICKING FOR YEARS.

The stock market’s damage has already been done. And if you’re one of those people near or already in retirement, you already know you’re going to have to work longer, save more or spend less...

...This economic downturn has been steep enough and frightening enough to undermine the idea that the stock market, over time, will always deliver. So a lot of investors have retreated to a more conservative stance.

The wisdom of that move is debatable. The investment industry warns that becoming too defensive is costly in the long run. Its argument goes something like this: People are living longer, retirement may last 25 or 30 years and stocks are supposed to protect you from the ravages of inflation. And since stocks tend to outpace most investments over long periods of time, the industry says, your savings will do all right in the end.

But some people are no longer comfortable with that logic...

...So what should retirees and pre-retirees make of all of this?

“If another decline in the market is going to bankrupt you or put you out of business or destroy your retirement account, you should not go back into the stock market,” said John C. Bogle, the founder of Vanguard and viewed by many as the father of index investing. “It’s not complicated. The stock market can go up and down a lot and nobody really knows how much and when.”

What’s worked for Mr. Bogle may not work for you, but his method isn’t a bad place to start. “I have this threadbare rule that has worked very well for me,” he said in an interview this week. “Your bond position should equal your age.” Mr. Bogle, by the way, is 80 years old.

There has been a lot of discussion in the media in recent months regarding the MBA qualification. An interesting piece in The Economist last week discussed the point in terms of Management not being a profession like Medicine and Law:

MBA students lead a campaign to turn management into a formal profession...

...400 students graduating from Harvard Business School... At an unofficial ceremony the day before they received their MBAs, the students promised they would, among other things, “serve the greater good”, “act with the utmost integrity” and guard against “decisions and behaviour that advance my own narrow ambitions, but harm the enterprise and the societies it serves.”

...When the business school was founded in 1908, the goal was to create something along the lines of Harvard’s medical and law schools. But the mission was soon abandoned, not least because there was no agreement about how managers should behave...

For me the MBA at Melbourne Business School was an three-pronged exercise in trying to teach some common-sense, team-work skills and decision-making to a group that seemed to be lacking in all three.

Reading an article in today's Australian it was noted that John Malkovich "once described himself as a midwesterner", not meaning small-town family values but as he reflected:

"To me midwesterner means (long pause) some degree of politeness, simple politeness. Some degree of common sense, an education towards problem solving, rather than problem dramatising or inventing."

Maybe the MBA, as taught in leading business schools, could be the "Midwestern Business Approach" contrasting with the east-coast of the USA (New York), where politeness and common sense seem to be lacking, and the west-coast (LA), where problem dramatising or inventing seems to prevail.

I like the idea. Management education could not go too wrong by focussing on simple politeness, common sense and problem solving.

Saturday, June 06, 2009

While on the plane to Albury this morning I read a very interesting article in Time. The title was How Twitter Will Change the Way We Live, but most interesting part for me was the reminder about how many truly innovative businesses come out of America:

...The speed with which users have extended Twitter's platform points to a larger truth about modern innovation. When we talk about innovation and global competitiveness, we tend to fall back on the easy metric of patents and Ph.D.s. It turns out the U.S. share of both has been in steady decline since peaking in the early '70s. (In 1970, more than 50% of the world's graduate degrees in science and engineering were issued by U.S. universities.) Since the mid-'80s, a long progression of doomsayers have warned that our declining market share in the patents-and-Ph.D.s business augurs dark times for American innovation. The specific threats have changed. It was the Japanese who would destroy us in the '80s; now it's China and India.

But what actually happened to American innovation during that period? We came up with America Online, Netscape, Amazon, Google, Blogger, Wikipedia, Craigslist, TiVo, Netflix, eBay, the iPod and iPhone, Xbox, Facebook and Twitter itself. Sure, we didn't build the Prius or the Wii, but if you measure global innovation in terms of actual lifestyle-changing hit products and not just grad students, the U.S. has been lapping the field for the past 20 years.

How could the forecasts have been so wrong? The answer is that we've been tracking only part of the innovation story. If I go to grad school and invent a better mousetrap, I've created value, which I can protect with a patent and capitalize on by selling my invention to consumers. But if someone else figures out a way to use my mousetrap to replace his much more expensive washing machine, he's created value as well. We tend to put the emphasis on the first kind of value creation because there are a small number of inventors who earn giant paydays from their mousetraps and thus become celebrities. But there are hundreds of millions of consumers and small businesses that find value in these innovations by figuring out new ways to put them to use...

The plane never actually made it to Albury this morning... We turned around because of fog in Albury and landed back in Sydney at 11:30AM... Will try again tomorrow morning... And yes, I will start using my new Twitter account soon --- it will probably take over from this blog in the next couple of months.

Saturday, May 30, 2009

"Hi - I'm the writer/director of this film... the music was actually specifically composed for this film, titled 'Helpless and Homeless' by Australian composer John Roy. It is not available as a track, so please enjoy it with the film and share with your friends - cheers, Jason"

Suddenly it seems as if everyone is talking about inflation. Stern opinion pieces warn that hyperinflation is just around the corner. And markets may be heeding these warnings: Interest rates on long-term government bonds are up, with fear of future inflation one possible reason for the interest-rate spike.

But does the big inflation scare make any sense? Basically, no — with one caveat I’ll get to later. And I suspect that the scare is at least partly about politics rather than economics.

First things first. It’s important to realize that there’s no hint of inflationary pressures in the economy right now. Consumer prices are lower now than they were a year ago, and wage increases have stalled in the face of high unemployment. Deflation, not inflation, is the clear and present danger.

So if prices aren’t rising, why the inflation worries? Some claim that the Federal Reserve is printing lots of money, which must be inflationary, while others claim that budget deficits will eventually force the U.S. government to inflate away its debt.

The first story is just wrong. The second could be right, but isn’t.

Now, it’s true that the Fed has taken unprecedented actions lately. More specifically, it has been buying lots of debt both from the government and from the private sector, and paying for these purchases by crediting banks with extra reserves. And in ordinary times, this would be highly inflationary: banks, flush with reserves, would increase loans, which would drive up demand, which would push up prices.

But these aren’t ordinary times. Banks aren’t lending out their extra reserves. They’re just sitting on them — in effect, they’re sending the money right back to the Fed. So the Fed isn’t really printing money after all...

...Yes, we have a long-run budget problem, and we need to start laying the groundwork for a long-run solution. But when it comes to inflation, the only thing we have to fear is inflation fear itself.

Friday, May 22, 2009

CAMBRIDGE, Mass. — Seventy-six years ago, Franklin Delano Roosevelt took to the inaugural dais and reminded a nation that its recent troubles “concern, thank God, only material things.” In the midst of the Depression, he urged Americans to remember that “happiness lies not in the mere possession of money” and to recognize “the falsity of material wealth as the standard of success.”

“The only thing we have to fear,” he claimed, “is fear itself.”

As it turned out, Americans had a great deal more to fear than that, and their innocent belief that money buys happiness was entirely correct. Psychologists and economists now know that although the very rich are no happier than the merely rich, for the other 99 percent of us, happiness is greatly enhanced by a few quaint assets, like shelter, sustenance and security. Those who think the material is immaterial have probably never stood in a breadline.Money matters and today most of us have less of it, so no one will be surprised by new survey results from the Gallup-Healthways Well-Being Index showing that Americans are smiling less and worrying more than they were a year ago, that happiness is down and sadness is up, that we are getting less sleep and smoking more cigarettes, that depression is on the rise.

But light wallets are not the cause of our heavy hearts. After all, most of us still have more inflation-adjusted dollars than our grandparents had, and they didn’t live in an unremitting funk. Middle-class Americans still enjoy more luxury than upper-class Americans enjoyed a century earlier, and the fin de siècle was not an especially gloomy time. Clearly, people can be perfectly happy with less than we had last year and less than we have now.

So if a dearth of dollars isn’t making us miserable, then what is? No one knows. I don’t mean that no one knows the answer to this question. I mean that the answer to this question is that no one knows — and not knowing is making us sick.

Consider an experiment by researchers at Maastricht University in the Netherlands who gave subjects a series of 20 electric shocks. Some subjects knew they would receive an intense shock on every trial. Others knew they would receive 17 mild shocks and 3 intense shocks, but they didn’t know on which of the 20 trials the intense shocks would come. The results showed that subjects who thought there was a small chance of receiving an intense shock were more afraid — they sweated more profusely, their hearts beat faster — than subjects who knew for sure that they’d receive an intense shock.

That’s because people feel worse when something bad might occur than when something bad will occur. Most of us aren’t losing sleep and sucking down Marlboros because the Dow is going to fall another thousand points, but because we don’t know whether it will fall or not — and human beings find uncertainty more painful than the things they’re uncertain about.

But why?

A colostomy reroutes the colon so that waste products leave the body through a hole in the abdomen, and it isn’t anyone’s idea of a picnic. A University of Michigan-led research team studied patients whose colostomies were permanent and patients who had a chance of someday having their colostomies reversed. Six months after their operations, patients who knew they would be permanently disabled were happier than those who thought they might someday be returned to normal.

Similarly, researchers at the University of British Columbia studied people who had undergone genetic testing to determine their risk for developing the neurodegenerative disorder known as Huntington’s disease. Those who learned that they had a very high likelihood of developing the condition were happier a year after testing than those who did not learn what their risk was.

Why would we prefer to know the worst than to suspect it? Because when we get bad news we weep for a while, and then get busy making the best of it. We change our behavior, we change our attitudes. We raise our consciousness and lower our standards. We find our bootstraps and tug. But we can’t come to terms with circumstances whose terms we don’t yet know. An uncertain future leaves us stranded in an unhappy present with nothing to do but wait.

Our national gloom is real enough, but it isn’t a matter of insufficient funds. It’s a matter of insufficient certainty. Americans have been perfectly happy with far less wealth than most of us have now, and we could quickly become those Americans again — if only we knew we had to.

Daniel Gilbert is professor of psychology at Harvard University and author of “Stumbling on Happiness.” More of his writing and videos of his appearances can be found at his Web site.